In July 2021, the government announced fundamental changes to the taxation of unincorporated business, including professional partnerships. Finance Act 2022 has now been enacted, confirming the changes will apply from 6 April 2024.
The new legislation will abolish the concept of basis periods for income tax, accelerating the point at which the tax is due on an unincorporated business’ profits where its accounting year end is not between 31 March and 5 April. From 2024/25, partners will be assessed on profits of the tax year, rather than the accounting year that ends in the tax year.
It is worth reading our previous content on the reform here and for background. Professional partnerships have additional points to address before the start of the transition year in 2023/24. This article focusses on those partnerships affected by the new rules i.e., those not with a year-end between 31 March and 5 April, and in particular, those who operate a tax reserve on behalf of their partners.
Application to professional partnerships
HMRC estimates two-thirds of partnerships do not draw up their accounts to 5 April or 31 March, leaving c.130k partnerships affected by the new legislation. This number will contain large professional partnerships whose partners typically incur significant income tax liabilities.
The finance teams at these professional partnerships should now be working through the impact of the reform on the cash flow/working capital of the firm, the partner tax reserves along with the practical and administrative aspects. Those firms with a 30 April year end will from 1 May 2022 move into the first accounting period impacted by the changes.
For the partners, they will be encouraged that the concept of overlap profits will be a thing of the past, with existing accrued overlap utilised as part of the transitional year calculations. However, filing with estimated or provisional figures each tax year will bring additional complexity.
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HMRC have suggested it expects some firms to switch to a 31 March year end. However, there are significant commercial reasons why such a change may not be viable for professional partnerships.
If your firm is considering a change of year end, we recommend seeking professional advice as early as possible to avoid the potential pitfalls, for example around the timing of the change.
Given the resulting impact on cash flow and working capital, some firms may revisit whether a partnership structure is still fit for purpose. We expect incorporation to be increasingly considered, although this will need to be tempered against the planned increase to the corporate tax rates from April 2023.
Professional partnerships may also need to address key internal policies. If a partner leaves within the five-year period over which transition profits are spread, the remaining transition profits are taxed in the final year. But will there be a scenario where it is beneficial to elect to tax more of the spread profit earlier? It is possible to opt out of the five-year spreading period and this option should not be discounted out of hand.
Partners will need to file a tax return with provisional figures each year. Take for example, a partnership with a 31 December year end. For the tax year 2025/26, a partner will apportion profits from both the accounts to 31 December 2025 and 31 December 2026. The filing date for 2025/26 is 31 January 2027, only one month after the 31 December 2026 period by which time is highly unlikely final accounts and tax-adjusted profit share information will be available.
HMRC has not yet confirmed how this provisional filing will interact with penalties and interest. Suggestions include an extension to the 31 January filing deadline for certain groups. Further guidance is expected from HMRC later in 2022.
The 2023/24 transitional year will see an increase in the amount of profit on which partners pay tax when more than 12 months profits will be assessed. Whilst brought forward overlap profits will be available to relieve against the transition profits, partners will want to be satisfied their firms hold sufficient reserves to cover the accelerated tax payments.
KPMG can support firms in navigating the impact of the reform on their business and partners. Please contact Richard Green if you would like an initial call to discuss the changes.